Enrico Camerinelli

enrico camerinelli - Aite Group

In the world of international trade, the process of exchanging payments, information and documents between buyers, sellers, banks, and other involved parties is becoming increasingly important for financial institutions. This community aims at presenting views and innovative ideas related to this financial supply chain space.

Why is Supply Chain Finance so Slow to Grow?

24 January 2013 | 7893 views | 4

There is no question that the principles of supply chain finance (SCF) are strong and that the correspondent benefits are considerable. The perspective to get financed on the basis of the client’s creditworthiness should line up multitudes of roaring companies
demanding for such an attractive—and apparently low cost—facility. Yet, reality shows that SCF programs are evolving very slowly and are far from widespread adoption. Financial institutions have invested significant resources in money, time, and staff to develop
and market SCF programs but have so far obtained relatively small returns compared to the initial expectations. Non-finance companies represent a growing SCF alternative to banks but their firepower is a small fraction of what financial institutions may put
in place.

An initial overview of the market and of its players suggests likely valid reasons for such a slow uptake:

The level of information among companies about SCF is still low

Banks are reluctant to change “old-fashioned” credit-checking, risk and collateral management processes and adapt them to the new offerings

Companies have already financing lines in place and do not want to change

Some large multinationals are already running self-made SCF programs

Companies do not line up finance specialists in SCF program teams

Accounting and auditing issues may advise against the introduction of SCF programs

Company internal disconnects between treasury and procurement functions represent a serious concern

These facts are however too general to detect what justifies the lack of SCF growth. I thought there was a need for deeper investigation and analysis. To simplify the work—and yet achieve significantly still valid results—I decided to focus my observations
on reverse factoring (a.k.a., approved payables finance). This instrument represents one of the most significant SCF solutions offered today. It would not be too distant from reality to consider reverse factoring
the preeminent SCF instrument. The fact that some banks call “supply chain finance” their reverse factoring product shows how much this financial instrument has grabbed the attention of the market and represents indeed the epitome of supply chain finance.

I have come to the conclusion that there is a sequence of facts that may explain why reverse factoring (hence, supply chain finance) programs grow so slow:

A large buyer approaches its bank asking to set up a reverse factoring program for a number of suppliers. The foundation of reverse factoring is that suppliers get financed by the bank on the basis of the creditworthiness of the buyer

The bank receives a mandate to approach the suppliers

Normally these suppliers are based in fast-growing or emerging foreign countries (see later the comment regarding domestic suppliers)

The bank is supposed to finance these companies, so has the need to properly review them under the lens of a full KYC procedure

Current regulatory pressures demand very strict KYC controls and thorough assessments of each company profile

Since the companies to control are based abroad, the bank must have a physical presence in each of the suppliers’ countries to execute the KYC mandate. Even with a physical presence onsite it will not always be feasible to conduct a compliant KYC control
due to lack of primary information from the company. Not all countries have the same levels of control and not all companies are provided with the proper systems to collect and store KYC required data

The bank may have a correspondent bank partner in the country, in which case the profiling of the supplier company can be somehow facilitated

It is however highly unlikely that the KYC norms allow for a “on-behalf-of” KYC check

The bank of the buyer company, at this stage, may decide to opt out from the reverse factoring program because the lack of KYC information risks to compromise its compliance to regulatory requirements

The cause of slow SCF programs resides in the lack of adequate information that allows a financial institution to comply with regulatory mandates

In case of domestic supplier companies the KYC issue is resolved. However, in such case there are already established SCF offerings that go under the name of “factoring”. Factoring is offered by specialized companies and by banks; both are enjoying very
profitable results from these business lines

Banks are therefore unwilling to touch their factoring business units

Domestic companies are also normally familiar with factoring as a source of receivables finance. In fact factoring business is growing at incredible high pace globally. Although companies lament the high costs of the factoring service they are hardly aware
of alternative solutions. On their side, banks have no real interest to distract the companies’ attention away from traditional factoring in favor of nascent reverse factoring. Why merge the bank’s lucrative factoring business—and loose revenue—into a (almost
still unknown) SCF line of business?

Conclusion

Slow adoption of SCF programs does not depend on lack of demand from companies. The steering wheel is squarely in the hands of banks (could it be otherwise?) that are either unable to comply with KYC controls or unwilling to cannibalize the very profitable
income of their factoring business units.

If banks are (really) interested to solve at least the KYC conundrum, they should work to a solution similar to the European Economic Area (EEA) “Passporting”(*). With Passporting, a document, having been approved by one EEA competent authority (Home Authority),
can be used as a “passport” for offers or listings in all other EEA countries, without further review or the imposition of further disclosure requirements by the relevant authority of that EEA country (Host Authority). Similarly, banks could work on a “KYC
Passporting” model.

As per the factoring business, nothing prevents banks from putting their factoring business under the wider Supply Chain Finance “umbrella”. If they choose not to, then banks will remain in the eyes of their corporate clients as product-centric dinosaurs
despite all the efforts and attempts from banks marketing to declare their dedication to a client- and solution-centric “cause”.

Comments: (7)

It is not the KYC compliance processes are to be blamed for the slow adoption of SCF program, rather the problem is with the very nature of the arrangement. Since it is a tripartite relationship between the buyer, IT vendor and sellers, all the parties should
understand the business benefit of the SCF arrangement. Beside if a seller is already enjoying a financing relationship with his banker, it is unlikely for him to create a new relationship with the SCF provider until and unless he sees a compelling business
reason for this.

"Slow adoption of SCF programs does not depend on lack of demand from companies. The steering wheel is squarely in the hands of banks (could it be otherwise?) that are either unable to comply with KYC controls or unwilling to cannibalize the very profitable
income of their factoring business units."

Slow adoption of SCF programs by the banks is partially subjective due to their inertia and the traditional operational silos but also objective:
- Managing value chain and SCF is not really their core competence
- Selling SCF big way requires changing their culture towards proactive
marketing and real competition, which they both do not know how to do.
- Regulators would not like it

The bottom line - it would require separate subsidiaries as for wealth
management or even serious factoring or leasing.>>

"If they choose not to, then banks will remain in the eyes of their
corporate clients as product-centric dinosaurs despite all the efforts and attempts from banks marketing to declare their dedication to a client- and solution-centric "cause"."

-- That's already very much in effect in the North America and the UK; I don't know about continental Europe but unlikely much different. The banks know about it, proud to be dinosaurs (they name it prudent) and can't be scared or pushed towards the action
by this argument.

As this article explains, for cross-border reverse factoring to work, it's necessary for the buyer's bank in two different countries to work together. Whether it's due to cultural differences or a tendency to protect their own turfs or whatever, different
subsidiaries of large MNCs don't seem to collaborate too well across their global operations. I've experienced this tendency across many industries, not just banks. In one personal experience, it was a nightmare to get a certain global IT company's Indian
subsidiary to act in consonance with the same company's UK subsidiary although both were serving the same MNC bank. Since the situation was critical, it was necessary to reach out to the company's US HQ, which finally intervened and enforced the required collaboration.
But, I doubt if such joint efforts would happen under BAU conditions, and I won't blame only banks for that.

You are making an excellent point of discussion. Effectively corporations have their part of responsibility as well. The treasurer vs. procurement as much as the subsidiary vs. HQ "conflicts"do seriously damage the success of any SCF program.

However it's up to the bank to ensure the company counterparts are all lined-up. That's why it's so important for the bank to "speak the client's language". That is, to understand the readiness of the company to embark on a SCF program.

The ability for one back to accept customers who have already had their identity verified at another bank is already available across many countries including the US, India and UK.

This ecosystem provides consumers with a purely online process to verify their identity to the same level as a manual document check (passport, driver's license, etc.).

The principle works very much like Enrico suggests to leverage identity checks that have already been done across the industry. From an industry perspective it reduces the operational cost of identity checking, reduces fraud risk by bringing together data
from across the industry and makes it easier for the consumer to do business online.

@MagnusB: "The ability for one back to accept customers who have already had their identity verified at another bank is already available across many countries including ... India ...". This would be great, but, it's news to me. In fact, as I'd highlighted
in my op-ed article titled "Impact of Regulation on Financial Services Providers" that appeared in
August 2012 issue of the Journal of Internet Banking And Commerce, the KYC done during the purchase of one product (e.g. savings account) from a bank does not even suffice for
the purchase of another product (e.g. pension) from the same bank. Furthermore, even the KYC done for one product has to be renewed every year or two, even for the same product. If you're referring to the newly launched UIDAI / Aadhar card, (1) It's issued
by the government and not by any bank (2) Most banks accept it only as proof of ID, not address, for which they continue to demand proof of residence documents issued by other banks / telcos / public authorities (not their own).